POLICY: The Three Percent Myth By Eric Novack M.D.

As the premier health policy blog on the net, I am honored that Matthew has asked me to occasionally guest post here. I also am regularly impressed with
  the level of thought and knowledge of so many posters of comments.
  Every once in a while, I think it is important to review, what I would believe
  so basic myths about our healthcare system. One of the greatest myths is the
  3% overhead myth for medicare. (This is often also cited as the 2% overhead
  Argument one in favor of the ‘medicare for all’ expansion of government
  regulated healthcare is the disparity in overhead between Medicare and private
  insurance plans. The Medicare overhead number is stated as 2% or 3%, depending
  upon where you read it. The overhead for private insurers is stated as 15%-25%.
  The disparity is used to explain the statement that, “if we just take the
  amount spent on wasted overhead and apply it to medicare-for-all, we could easily
  pay for everyone to be covered”. Where does that math come from? Here’s
  the brief skinny:
  $2 trillion in healthcare. 50% from private sector= $1trillion. Reduce overhead
  by 15-20%= $150- $200 billion available.
  Oh, if it was so simple.
  Let’s attack the 3% myth.

Proponents say overhead should be calculated as: admin costs/ payout for services.
  However, medicare recipients use much more care, on average, than younger groups.
  So, for example (made up numbers), medicare recipients might use $5000 per year,
  while commercially insured people might use $3000 per year. If both groups consisted
  of 10,000 people, it would take the same amount of oversight, management, etc.,
  yet the perceived overhead to take care of the younger group would be much higher;
  or put the other way, medicare overhead would be much lower.Solution: calculate overhead on a ‘per enrollee’ scale. This alone
  accounts for 50% of the discrepancy in overhead between medicare and private
  payers. If you do not believe me, just check with the Kaiser Foundation research
  saying the same thing.
  Proponents focus on the low administrative costs, on the one hand, while denouncing
  the amount of fraud by hospitals, providers. This perhaps is because medicare  does not spend enough on administrative oversight of the program. This happens to be exactly what the GAO and the National Academy of Social Insurance has  said within the past 6 years. So, if medicare spent more on administration,
  the discrepancy would be decreased even further.
  Proponents fail to account that for every regulation, costs are incurred by
  providers to comply. The 100,000 plus pages of medicare regulations function
  as an unfunded mandate on providers. Currently, the coding is based on ICD-9,
  which has over 24,000 codes. ICD-10, slated to go into effect within the next
  2 years has over 207,000!!!! And does upgrading for the change count toward medicare overhead? Of course not.
  Proponents say that private insurance company rules would create as much hassle
  for providers. Perhaps, but we will never know since private insurance rules
  are based off of the medicare guidelines.
  Thus, the ‘medicare 3% myth’, is, in reality, just that: a myth.

But like most myths, true believers will never pay attention to facts.

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17 replies »

  1. I agree with George

    This looks like a lobby site, they have no interest in facts or reality, American Health Insurance Corporations are Preditory Criminals! when it comes to making a decision between Their Money and Your Life, they will choose their money every time, you can bank on it!

    just google:
    Health Insurance CEO pay
    Health Insurance greed
    McGuire’s payday
    Ms. Angela Braly of WellPoint received total compensation of $13,108,198 in 2009
    House energy panel asks 52 companies to cough up info on everyone who makes more than $500,000 a year. Insurers cry foul. Does health CEO pay matter?

  2. yea, right this is what you get if you disagree…

    Cheating huh

    Protected by: AVH First Defense Against Spam

  3. The fact that the author admits to using “made up numbers” to support the point tells me that the analysis is bogus. This is just more propaganda. Unverified ramblings.

  4. This group brings up an interesting (if rather dated) argument that is constantly brought up in an attempt to show that Medicare cannot be as good as private insurers. The 2-3% figure is, as many in the group point out, a figure arrived at by looking at gross payment rather than per/patient claims. The argument is made that administrative costs and overhead should be looked at in the per-capita figure (which, by the way still gives Medicare a $133 to $271 per person advantage according to the Keiser Family Foundation), but in truth this does not truly look at administrative costs at all.
    Healthcare providers know that much of the administrative costs for patients are involved in ordering tests, treatments, getting approval for referrals and other dealings with the insurance companies. The fact is that private insurance has picked and chose their patients carefully so that there would be fewer claims, and then they throw every obstacle in the way to prevent claims. On the other hand Medicare insures everyone who applies!
    That is partly why their per capita claims are higher. These patients have to have more tests, therapies and consults and therefore are more expensive. In both Medicare and private insurance, each one of those steps is subject to administrative oversight and thus cost. This is where the real overhead is, and why the math should be done per $ and not per claim.
    Recently, (October 2007) the United States House of Representatives Committee on Oversight and Government Reform published it’s finding on the administrative costs of Medicare D (a privatized drug prescription plan for Medicare) versus traditional Medicare. They found that Medicare D administrative costs were 6 times higher than traditional Medicare! Of the average $180 per enrollee only $30 went to “Sales Cost”, while $107 went to administrative costs and $43 went to profit.
    But, this is only part of the problem. The cumbersome dealings with private insurance make it more difficult for healthcare providers to practice evidence based medicine. This, we (Healthcare Providers for Healthcare Reform- http://healthcare-reform.org/) believe is the key to why we pay twice as much per capita for healthcare than any other country in the world but are near the bottom of the 30 OECD countries in life expectancy from birth, infant mortality and maternal mortality.
    In fact the benefit of Medicare on health has been supported in 2 recent papers. In the New England Journal of Medicine (2007;357:1221-8), one can see that the life expectancy from age 65 (when Medicare kicks in) compared to other OECD countries is markedly better than total life expectancy. In a recent JAMA paper (2007 Dec 26;298(24):2886-94), the authors showed that before age 65, there is a steeper decline in health status among the uninsured compared with those with health insurance. The drop in the uninsured’s health started to reverse once Medicare coverage kicks in at age 65. In fact, by age 70, the difference in health between the two groups was about half what would be expected in the absence of Medicare coverage.
    We need some form of universal coverage to restore the health of this country and we believe that we have a workable plan that will incorporate the best of government run and privately run insurance.

  5. I’m a neophyte but I have a couple of questions:
    1) The assumption with the PMPM is that the medicare consumer and the private consumer have the same amount of visits but the former gets a bigger bill, skewing the admin ratio. But don’t old people go to the doctor a lot more? And doesn’t each trip generate admin? PMPM might be a useful number but I still think its apples-oranges.
    2) Do these numbers take in the amount of admin at the doctor’s office level. Some doctors hire another full time person just to figure out billing.

  6. Right on, JD. That explains this quote from the CEO of BCBS of Kansas City in the April 13 edition of the Kansas City Business Journal:
    During an address at The Central Exchange on Wednesday, Tom Bowser, CEO of BCBSKC, said 13 cents to 15 cents of every health care dollar that travels through the private third-party payer system goes to administration.
    That compares with 2 cents to 3 cents a dollar in the Medicare system, Bowser said.
    Eric’s “myth” seems to be so pervasive that the CEO of an 880,000-member health plan buys it. I guess Eric knows things he doesn’t. Hmmmm.

  7. This is an excellent post and discussion, but something critical has been left out thus far: from Medicare’s inception it has been private contractors (primarily BCBS plans) that have done the bulk of the operational administration. Medicare outsources claims processing, customer service, etc., to private insurers.
    So even if that 3% figure were true, it doesn’t argue against the possibility that private companies could administer US health insurance efficiently.
    Here are additional ways in which a primarily private insurance system could save admin costs:
    1. have the power to dictate rates rather than negotiate them individually with provider groups.
    2. Be able to dispense with underwriting, in favor of community rating or some other system.
    3. Do away with brokers, GAs and other middlemen who consumer about 4% of commercial premiums and for some PPOs constitute a large percentage of total admin costs. The high sales costs of private plans are in large part just payments to brokers. Create a public information system that will allow us to get rid of these middlemen.
    4. Merge to create larger entities with greater economies of scale…rivalling those of Medicare. This will work only so long as the giant insurers don’t reduce competition in local markets beyond a certain point, however.
    Finally, as Eric pointed out, several percentage points of the difference in expenses is just the result of the higher per member medical claims of Medicare members. I believe the real numbers are around $9K for a Medicare recipient and $5-6K for the commercially insured.

  8. The other think to point about Medical Loss Ratios (this is roughly the portion of your premium dollar spent on medical care) is that there is a wide variance in how insurance carriers are allowed (state regulated) to define which costs are considered “medical care” costs.
    Take, for example, the costs involved in “managing” care… authorizations, treatment plans, formulary restrictions, appeals and grievances… these may or may not get rolled into the medical loss ratio. Now these are — in my opinion — administrative costs, and not truly related to direct care.
    Carve-outs are another fuzzy area. For example, in Maryland we’ve been trying to change the law to prohibit applying the entire cost of mental health carve-outs to direct medical care costs.
    Just a couple points to add to the notion that this is a complex issue.

  9. > I also agree that private insurers would have needed
    > to come up with coding/billing/etc. regulations in
    > the absence of medicare… but I suspect that they
    > would not be so arcane or cumbersome.
    I think that they’d be just as complex — maybe more — because the private insurers have the same information needs the government has. We might’ve gotten more clinical information earlier had the coding/claims system developed by CMS (nee HCFA) been done by managed care organizations instead. But that’s pure speculation.
    I am not positive that the cost of developing the Medicare regulations is included in the famous “3%”. And I don’t think the cost of enforcing the regulations is included either.
    Here is a paper on the topic. I have not read it carefully, but it raises the two points above, plus more.
    I think Eric’s right: 3% is very “optimistic”.

  10. Jonathan– I will agree that, in the end, a complete analysis (should one be possible) could show that medicare for all might have slightly lower administrative costs. That would not, of course, mean necessarily that it would be a better system.
    I also agree that private insurers would have needed to come up with coding/billing/etc. regulations in the absence of medicare… but I suspect that they would not be so arcane or cumbersome. Additionally, any changes would have direct financial consequences on the private insurer that might act as a deterrent to high cost/ low benefit changes. (but I cannot be certain…)
    I do, however, stand by my point that 3% overhead- the daily mantra of the medicare-for-all proponents- is patently untrue.

  11. Erick, let’s say for the sake of the discussion, that Medicare admin costs are 3% and private insurance is 20%. (never mind that my group plan’s admin is under 5%)
    And let’s suppose that the Medicare program were extended to all citizens and that the nation realizes the 17% savings in year one. That’s a pretty big savings, and is well worth trying to figure out how to realize it.
    But health benefits costs are rising roughly 8% to 10% per year. That’s also a pretty big number.
    From where I sit it looks like in two years, max, the overall growth in health benefits cost will have overcome the admin savings, and we’re right back where we started – except that the health benefits costs will continue to grow at 8% to 10% per year.
    I’m not trying to say the admin savings aren’t worth going after. But what then?

  12. Even if a Medicare for all system has a possible (not necessarily certain) cost advantage over a system based on private insurance, I wonder about two things — (1) what is the cost of fraud in the current system due to Medicare (and Medicaid’s) inadequate oversight? and (2) given the generally low reimbursement rates based on dictated prices and monopsony power, what would be the impact on risk taking and innovation, related to the development of new drugs, medical equpment and devices and more effective / less invasive surgical procedures? Furthermore, it appears highly unlikely that any administrative savings that materialized under a Medicare for all system would be anywhere near sufficient to cover the currently uninsured.

  13. Thoughtful post, Eric. But I want to address one of your points.
    If I understand you correctly, you argue that (a) there is “hidden” overhead in Medicare because of the expense providers incur by complying with Medicare regulations (b) once you account for that, its apparent advantage in administrative costs diminishes.
    I’m fine with (a). But if we want to do an apples-to-apples comparison, then we need to account for the hidden overhead in private insurance, too. And there’s a lot of it, starting with the fact that providers must deal with so many different insurers. You can see this at virtually every level, from the solo practitioner (what few there are still out there) up to the large hopsitals. So I think that’s a powerful argument against (b).
    Keep in mind, too, that if Medicare didn’t have such a complicated regulatory scheme — on which private insurance essentially piggybacks — the private sector would have to invent something like it.
    One last note: I agree Medicare would benefit from more spending on administration, to cut down on waste and encourage higher quality care. But some would suggest — and I’m inclined to agree — that there’s room to do that and *still* end up with lower administrative costs. Just because the figures we see are “misleading” doesn’t mean there’s no gap — and that it doesn’t still favor Medicare.

  14. Maggie– data from– http://www.kff.org/medicare/upload/The-Federal-Employees-Health-Benefits-Program-Program-Design-Recent-Performance-and-Implications-for-Medicare-Reform-Report.pdf
    the information is from the top of page 8 of the study (page 13 of the pdf file).
    Here is the quote:
    These percentage comparisons [about overhead] may be deceptive, because service costs for Medicare
    beneficiaries are much higher than those for FEHBP enrollees. The two programs might spend
    the same dollar amounts on administration, but Medicare’s spending would appear lower as a
    percent of claims. Absolute dollar amounts for private insurance administration are difficult to
    obtain, but one source does produce estimates for Blue Cross Blue Shield plans. For plans
    operating a PPO on an administrative services-only basis—essentially the way Blue Cross
    operates under FEHBP—mean administrative costs per member year were $271 in 2002
    (Sherlock Company, 2002). Medicare’s costs in 2002, $4.8 billion for about 36 million fee-forservice
    beneficiaries, were about $133 per beneficiary, or about one-half as large.
    Rick- good comments, but they fail to account for two pieces of my post: first, you do not address the potential lack of administration at CMS, which would substantially increase ACR. Second, you do not comment upon the distributed costs to providers to fund the infrastructure of the medicare program and its vast regulations.
    The equation suggests a model for all commerce that the government could do it cheaper, a statement I do not believe you are making.

  15. Eric,
    I respect the fact that you made an attempt to express the figures honestly, but you’re kinda talking past the issue, and leaving a bunch of important stuff out. The 15-25% that private health plans incur as administrative expenses (usually called administrative cost ratio, or ACR) include marketing, which Medicare-for-all would either not need to do, or would do in a very limited capacity (I picture something like you go to a bureaucrat office, show your birth certificate and driver’s license, and boom, you’re in). You’re also leaving out profit, which comes on top of both ACR and Medical Loss Ratio (or MLR), which is the cost of delivering actual care.
    Now, while it’s true, as you point out, that the per-member, per-month (PMPM) cost of a Medicare patient is higher (private insurers report anywhere from $700 to $900, depending) than for a commercial member (private insurers report around ($225 to $300, depending), that doesn’t get us around the fact that in both instances, the private insurer must bear (and pass on to members) the cost of marketing itself, and must deliver a fair profit to its shareholders (the industry average is about 6 percent of total revenues).
    So total revenues for a health plan must cover MLR + ACR + Profit. But for Medicare, total revenues must only cover MLR + ACR – Marketing. No myth in that. Just explain to me how the sum of MLR + ACR + Profit < MLR + ACR – Marketing, on populations that are equal in all other respects. I don't think that can be proven.

  16. Could you give us a link to the Kaiser Foundation research that you cite?